Statistical model selection criteria provide an informed choice of the model with best external (... more Statistical model selection criteria provide an informed choice of the model with best external (i.e., out-of-sample) validity. Therefore they guard against overfitting ("data snooping"). We implement several model selection criteria in order to verify recent evidence of predictability in excess stock returns and to determine which variables are valuable predictors. We confirm the presence of in-sample predictability in an international stock market dataset, but discover that even the best prediction models have no out-of-sample forecasting power. The failure to detect out-of-sample predictability is not due to lack of power.
INSEAD An asymmetric information model of the bid-ask spread is developed for foreign exchange ma... more INSEAD An asymmetric information model of the bid-ask spread is developed for foreign exchange market subject to occasional government interventions. Traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes. Larger bid-ask spreads on Fridays are documented. Reliable evidence of asymmetric bid-ask spreads for all days of the week, albeit more pronounced on Fridays, are presented. The null hypotesis that the forward rate is an unbiased predictor of the future spot rate continues to be rejected. The regression slope coefficients increase toward unity, however, indicating a less variable risk premium.
There appear to be no anomalies in the aftermarket of a sample of 4,848 US IPOs over the period 1... more There appear to be no anomalies in the aftermarket of a sample of 4,848 US IPOs over the period 1975 to 1995, except issues offered below $6. Risk is priced in the aftermarket in accordance with Rubin-stein's asset-pricing model. Unlike under the efficient markets ...
Speculators buy an asset hoping to sell it later to investors with higher private valuations. If ... more Speculators buy an asset hoping to sell it later to investors with higher private valuations. If agents are uncertain about the distribution of private valuations and about the beliefs of others about this distribution, a beauty contest with an infinite hierarchy of beliefs arises. Under Harsanyi's assumption of a common prior the infinite beliefs hierarchy is readily solved using Bayes' law. This paper shows that common knowledge of the "beliefs formation rule," mapping the private valuation of each agent into his first-order belief, also simplifies the beliefs hierarchy while allowing for disagreement among agents. We analyse the resulting speculation in a stylized asset market. Several statistics, computed only from readily observable quote, return and volume data, are evaluated in terms of their power to discriminate between genuine disagreement and the Harsanyian case. Only statistics that relate volume and volatility, or volume and changes in best offers, have the necessary discriminatory power.
We analyse the optimal Initial Public Offering (IPO) mechanism in a multidimensional adverse sele... more We analyse the optimal Initial Public Offering (IPO) mechanism in a multidimensional adverse selection setting where institutional investors have private information about the market valuation of the shares, the intermediary has private information about the demand, and the institutional investors and intermediary collude. Theorem I states that uniform pricing is optimal (all agents pay the same price) and characterizes the IPO price in terms of conditional expectations. Theorem 2 states that the optimal mechanism can be implemented by a non-linear price schedule decreasing in the quantity allocated to retail investors. This is similar to IPO procedures used in the U.K. and France. Relying on French IPO data we perform a GMM structural estimation and test of the model. The price schedule is estimated and the conditions characterizing the optimal mechanism are not rejected.
Philosophical Transactions of the Royal Society B: Biological Sciences, 2008
The acknowledged importance of uncertainty in economic decision making has stimulated the search ... more The acknowledged importance of uncertainty in economic decision making has stimulated the search for neural signals that could influence learning and inform decision mechanisms. Current views distinguish two forms of uncertainty, namely risk and ambiguity, depending on whether the probability distributions of outcomes are known or unknown. Behavioural neurophysiological studies on dopamine neurons revealed a risk signal, which covaried with the standard deviation or variance of the magnitude of juice rewards and occurred separately from reward value coding. Human imaging studies identified similarly distinct risk signals for monetary rewards in the striatum and orbitofrontal cortex (OFC), thus fulfilling a requirement for the mean variance approach of economic decision theory. The orbitofrontal risk signal covaried with individual risk attitudes, possibly explaining individual differences in risk perception and risky decision making. Ambiguous gambles with incomplete probabilistic information induced stronger brain signals than risky gambles in OFC and amygdala, suggesting that the brain's reward system signals the partial lack of information. The brain can use the uncertainty signals to assess the uncertainty of rewards, influence learning, modulate the value of uncertain rewards and make appropriate behavioural choices between only partly known options.
An empirical version of the Cox, lngersoll. and Ross (1985a) call option pricing model is derived... more An empirical version of the Cox, lngersoll. and Ross (1985a) call option pricing model is derived, assuming execution price uncertainty in the options market. The pricing restrictions come in the form of moment conditions in the option pricing error. These can be estimated and tested using a version of the method of simulated moments (MSM). Simulation estimates, obtained by discretely approximating the risk-neutral processes of the underlying stock price and the interest rate, are substituted for analytically unknown call prices. The asymptotics and other aspects of the MSM estimator are discussed. The model is tested on transaction prices at 15-minute intervals. It substantially outperforms the Black-Scholes model. The empirical success of the Cox-Ingersoll-Ross model implies that the continuous-time interest rate implicit in synchronous transaction quotes of 90day Treasury-bill futures contracts is an-albeit noisy-proxy for the instantaneous volatility on common stock. The process of the instantaneous volatility is found to be close to nonstationary. It is well approximated by a heteroskedastic unit-root process. With this approximation, the Cox-Ingersoll-Ross model only slightly overprices long-maturity options.
When continuous-time portfolio weights are applied to a discrete-time hedging problem, errors are... more When continuous-time portfolio weights are applied to a discrete-time hedging problem, errors are likely to occur. This paper evaluates the overall importance of the discretization-induced tracking error. It does so by comparing the performance of Black-Scholes hedge ratios against those obtained from a novel estimation procedure, namely local parametric estimation. In the latter, the weights of the duplicating portfolio are
Most accounts of the function of anterior insula in the human brain refer to concepts that are di... more Most accounts of the function of anterior insula in the human brain refer to concepts that are difficult to formalize, such as feelings and awareness. The discovery of signals that reflect risk assessment and risk learning, however, opens the door to formal analysis. Hitherto, activations have been correlated with objective versions of risk and risk prediction error, but subjective versions (influenced by pessimism/optimism or risk aversion/tolerance) exist. Activation in closely related cortical structures has been found to be both objective (anterior cingulate cortex) and subjective (inferior frontal gyrus). For this quantitative analysis of uncertainty-induced neuronal activation to further understanding of insula's role in feelings and awareness, however, formalization and documentation of the relation between uncertainty and feelings/awareness will be needed. One obvious starting point is the link with failure anxiety and error awareness.
Proceedings of the National Academy of Sciences of the United States of America, Jan 6, 2008
Competing successfully against an intelligent adversary requires the ability to mentalize an oppo... more Competing successfully against an intelligent adversary requires the ability to mentalize an opponent's state of mind to anticipate his/her future behavior. Although much is known about what brain regions are activated during mentalizing, the question of how this function is implemented has received little attention to date. Here we formulated a computational model describing the capacity to mentalize in games. We scanned human subjects with functional MRI while they participated in a simple two-player strategy game and correlated our model against the functional MRI data. Different model components captured activity in distinct parts of the mentalizing network. While medial prefrontal cortex tracked an individual's expectations given the degree of model-predicted influence, posterior superior temporal sulcus was found to correspond to an influence update signal, capturing the difference between expected and actual influence exerted. These results suggest dissociable contrib...
Local Polynomial Estimation (LPE) is implemented on a dataset of high-frequency foreign exchange(... more Local Polynomial Estimation (LPE) is implemented on a dataset of high-frequency foreign exchange(FX) quotes. This nonparametric technique is meant to provide a flexible background against whichto evaluate parametric time series models. Assuming a conditionally heteroscedastic nonlinear autoregressive(CHARN) model, estimates of the mean and volatility functions are reported. Themean function displays pronounced reversion. Surprisingly, the volatility function exhibits asymmetry.The CHARN...
Consensus building in a group is a hallmark of animal societies, yet little is known about its un... more Consensus building in a group is a hallmark of animal societies, yet little is known about its underlying computational and neural mechanisms. Here, we applied a computational framework to behavioral and fMRI data from human participants performing a consensus decision-making task with up to five other participants. We found that participants reached consensus decisions through integrating their own preferences with information about the majority group members' prior choices, as well as inferences about how much each option was stuck to by the other people. These distinct decision variables were separately encoded in distinct brain areas-the ventromedial prefrontal cortex, posterior superior temporal sulcus/temporoparietal junction, and intraparietal sulcus-and were integrated in the dorsal anterior cingulate cortex. Our findings provide support for a theoretical account in which collective decisions are made through integrating multiple types of inference about oneself, others,...
The Journal of neuroscience : the official journal of the Society for Neuroscience, Jan 18, 2015
Economic choices are largely determined by two principal elements, reward value (utility) and pro... more Economic choices are largely determined by two principal elements, reward value (utility) and probability. Although nonlinear utility functions have been acknowledged for centuries, nonlinear probability weighting (probability distortion) was only recently recognized as a ubiquitous aspect of real-world choice behavior. Even when outcome probabilities are known and acknowledged, human decision makers often overweight low probability outcomes and underweight high probability outcomes. Whereas recent studies measured utility functions and their corresponding neural correlates in monkeys, it is not known whether monkeys distort probability in a manner similar to humans. Therefore, we investigated economic choices in macaque monkeys for evidence of probability distortion. We trained two monkeys to predict reward from probabilistic gambles with constant outcome values (0.5 ml or nothing). The probability of winning was conveyed using explicit visual cues (sector stimuli). Choices between...
Ce document est publié dans lintention de rendre accessibles les résultats préliminaires de la re... more Ce document est publié dans lintention de rendre accessibles les résultats préliminaires de la recherche effectuée au CIRANO, afin de susciter des échanges et des suggestions. Les idées et les opinions émises sont sous lunique responsabilité des auteurs, et ne représentent pas nécessairement les positions du CIRANO ou de ses partenaires. This paper presents preliminary research carried out at CIRANO and aims to encourage discussion and comment. The observations and viewpoints expressed are the sole responsibility of the authors. They do not necessarily represent positions of CIRANO or its partners. CIRANO Le CIRANO est une corporation privée à but non lucratif constituée en vertu de la Loi des compagnies du Québec. Le financement de son infrastructure et de ses activités de recherche provient des cotisations de ses organisations-membres, dune subvention dinfrastructure du ministère de lIndustrie, du Commerce, de la Science et de la Technologie, de même que des subventions et mandats obtenus par ses équipes de recherche. La Série Scientifique est la réalisation dune des missions que sest données le CIRANO, soit de développer lanalyse scientifique des organisations et des comportements stratégiques. CIRANO is a private non-profit organization incorporated under the Québec Companies Act. Its infrastructure and research activities are funded through fees paid by member organizations, an infrastructure grant from the Ministère de lIndustrie, du Commerce, de la Science et de la Technologie, and grants and research mandates obtained by its research teams. The Scientific Series fulfils one of the missions of CIRANO: to develop the scientific analysis of organizations and strategic behaviour.
The capacity for strategic thinking about the payoff-relevant actions of conspecifics is not well... more The capacity for strategic thinking about the payoff-relevant actions of conspecifics is not well understood across species. We use game theory to make predictions about choices and temporal dynamics in three abstract competitive situations with chimpanzee participants. Frequencies of chimpanzee choices are extremely close to equilibrium (accurate-guessing) predictions, and shift as payoffs change, just as equilibrium theory predicts. The chimpanzee choices are also closer to the equilibrium prediction, and more responsive to past history and payoff changes, than two samples of human choices from experiments in which humans were also initially uninformed about opponent payoffs and could not communicate verbally. The results are consistent with a tentative interpretation of game theory as explaining evolved behavior, with the additional hypothesis that chimpanzees may retain or practice a specialized capacity to adjust strategy choice during competition to perform at least as well as...
Statistical model selection criteria provide an informed choice of the model with best external (... more Statistical model selection criteria provide an informed choice of the model with best external (i.e., out-of-sample) validity. Therefore they guard against overfitting ("data snooping"). We implement several model selection criteria in order to verify recent evidence of predictability in excess stock returns and to determine which variables are valuable predictors. We confirm the presence of in-sample predictability in an international stock market dataset, but discover that even the best prediction models have no out-of-sample forecasting power. The failure to detect out-of-sample predictability is not due to lack of power.
INSEAD An asymmetric information model of the bid-ask spread is developed for foreign exchange ma... more INSEAD An asymmetric information model of the bid-ask spread is developed for foreign exchange market subject to occasional government interventions. Traditional tests of the unbiasedness of the forward rate as a predictor of the future spot rate are shown to be inconsistent when the rates are measured as the average of their respective bid and ask quotes. Larger bid-ask spreads on Fridays are documented. Reliable evidence of asymmetric bid-ask spreads for all days of the week, albeit more pronounced on Fridays, are presented. The null hypotesis that the forward rate is an unbiased predictor of the future spot rate continues to be rejected. The regression slope coefficients increase toward unity, however, indicating a less variable risk premium.
There appear to be no anomalies in the aftermarket of a sample of 4,848 US IPOs over the period 1... more There appear to be no anomalies in the aftermarket of a sample of 4,848 US IPOs over the period 1975 to 1995, except issues offered below $6. Risk is priced in the aftermarket in accordance with Rubin-stein's asset-pricing model. Unlike under the efficient markets ...
Speculators buy an asset hoping to sell it later to investors with higher private valuations. If ... more Speculators buy an asset hoping to sell it later to investors with higher private valuations. If agents are uncertain about the distribution of private valuations and about the beliefs of others about this distribution, a beauty contest with an infinite hierarchy of beliefs arises. Under Harsanyi's assumption of a common prior the infinite beliefs hierarchy is readily solved using Bayes' law. This paper shows that common knowledge of the "beliefs formation rule," mapping the private valuation of each agent into his first-order belief, also simplifies the beliefs hierarchy while allowing for disagreement among agents. We analyse the resulting speculation in a stylized asset market. Several statistics, computed only from readily observable quote, return and volume data, are evaluated in terms of their power to discriminate between genuine disagreement and the Harsanyian case. Only statistics that relate volume and volatility, or volume and changes in best offers, have the necessary discriminatory power.
We analyse the optimal Initial Public Offering (IPO) mechanism in a multidimensional adverse sele... more We analyse the optimal Initial Public Offering (IPO) mechanism in a multidimensional adverse selection setting where institutional investors have private information about the market valuation of the shares, the intermediary has private information about the demand, and the institutional investors and intermediary collude. Theorem I states that uniform pricing is optimal (all agents pay the same price) and characterizes the IPO price in terms of conditional expectations. Theorem 2 states that the optimal mechanism can be implemented by a non-linear price schedule decreasing in the quantity allocated to retail investors. This is similar to IPO procedures used in the U.K. and France. Relying on French IPO data we perform a GMM structural estimation and test of the model. The price schedule is estimated and the conditions characterizing the optimal mechanism are not rejected.
Philosophical Transactions of the Royal Society B: Biological Sciences, 2008
The acknowledged importance of uncertainty in economic decision making has stimulated the search ... more The acknowledged importance of uncertainty in economic decision making has stimulated the search for neural signals that could influence learning and inform decision mechanisms. Current views distinguish two forms of uncertainty, namely risk and ambiguity, depending on whether the probability distributions of outcomes are known or unknown. Behavioural neurophysiological studies on dopamine neurons revealed a risk signal, which covaried with the standard deviation or variance of the magnitude of juice rewards and occurred separately from reward value coding. Human imaging studies identified similarly distinct risk signals for monetary rewards in the striatum and orbitofrontal cortex (OFC), thus fulfilling a requirement for the mean variance approach of economic decision theory. The orbitofrontal risk signal covaried with individual risk attitudes, possibly explaining individual differences in risk perception and risky decision making. Ambiguous gambles with incomplete probabilistic information induced stronger brain signals than risky gambles in OFC and amygdala, suggesting that the brain's reward system signals the partial lack of information. The brain can use the uncertainty signals to assess the uncertainty of rewards, influence learning, modulate the value of uncertain rewards and make appropriate behavioural choices between only partly known options.
An empirical version of the Cox, lngersoll. and Ross (1985a) call option pricing model is derived... more An empirical version of the Cox, lngersoll. and Ross (1985a) call option pricing model is derived, assuming execution price uncertainty in the options market. The pricing restrictions come in the form of moment conditions in the option pricing error. These can be estimated and tested using a version of the method of simulated moments (MSM). Simulation estimates, obtained by discretely approximating the risk-neutral processes of the underlying stock price and the interest rate, are substituted for analytically unknown call prices. The asymptotics and other aspects of the MSM estimator are discussed. The model is tested on transaction prices at 15-minute intervals. It substantially outperforms the Black-Scholes model. The empirical success of the Cox-Ingersoll-Ross model implies that the continuous-time interest rate implicit in synchronous transaction quotes of 90day Treasury-bill futures contracts is an-albeit noisy-proxy for the instantaneous volatility on common stock. The process of the instantaneous volatility is found to be close to nonstationary. It is well approximated by a heteroskedastic unit-root process. With this approximation, the Cox-Ingersoll-Ross model only slightly overprices long-maturity options.
When continuous-time portfolio weights are applied to a discrete-time hedging problem, errors are... more When continuous-time portfolio weights are applied to a discrete-time hedging problem, errors are likely to occur. This paper evaluates the overall importance of the discretization-induced tracking error. It does so by comparing the performance of Black-Scholes hedge ratios against those obtained from a novel estimation procedure, namely local parametric estimation. In the latter, the weights of the duplicating portfolio are
Most accounts of the function of anterior insula in the human brain refer to concepts that are di... more Most accounts of the function of anterior insula in the human brain refer to concepts that are difficult to formalize, such as feelings and awareness. The discovery of signals that reflect risk assessment and risk learning, however, opens the door to formal analysis. Hitherto, activations have been correlated with objective versions of risk and risk prediction error, but subjective versions (influenced by pessimism/optimism or risk aversion/tolerance) exist. Activation in closely related cortical structures has been found to be both objective (anterior cingulate cortex) and subjective (inferior frontal gyrus). For this quantitative analysis of uncertainty-induced neuronal activation to further understanding of insula's role in feelings and awareness, however, formalization and documentation of the relation between uncertainty and feelings/awareness will be needed. One obvious starting point is the link with failure anxiety and error awareness.
Proceedings of the National Academy of Sciences of the United States of America, Jan 6, 2008
Competing successfully against an intelligent adversary requires the ability to mentalize an oppo... more Competing successfully against an intelligent adversary requires the ability to mentalize an opponent's state of mind to anticipate his/her future behavior. Although much is known about what brain regions are activated during mentalizing, the question of how this function is implemented has received little attention to date. Here we formulated a computational model describing the capacity to mentalize in games. We scanned human subjects with functional MRI while they participated in a simple two-player strategy game and correlated our model against the functional MRI data. Different model components captured activity in distinct parts of the mentalizing network. While medial prefrontal cortex tracked an individual's expectations given the degree of model-predicted influence, posterior superior temporal sulcus was found to correspond to an influence update signal, capturing the difference between expected and actual influence exerted. These results suggest dissociable contrib...
Local Polynomial Estimation (LPE) is implemented on a dataset of high-frequency foreign exchange(... more Local Polynomial Estimation (LPE) is implemented on a dataset of high-frequency foreign exchange(FX) quotes. This nonparametric technique is meant to provide a flexible background against whichto evaluate parametric time series models. Assuming a conditionally heteroscedastic nonlinear autoregressive(CHARN) model, estimates of the mean and volatility functions are reported. Themean function displays pronounced reversion. Surprisingly, the volatility function exhibits asymmetry.The CHARN...
Consensus building in a group is a hallmark of animal societies, yet little is known about its un... more Consensus building in a group is a hallmark of animal societies, yet little is known about its underlying computational and neural mechanisms. Here, we applied a computational framework to behavioral and fMRI data from human participants performing a consensus decision-making task with up to five other participants. We found that participants reached consensus decisions through integrating their own preferences with information about the majority group members' prior choices, as well as inferences about how much each option was stuck to by the other people. These distinct decision variables were separately encoded in distinct brain areas-the ventromedial prefrontal cortex, posterior superior temporal sulcus/temporoparietal junction, and intraparietal sulcus-and were integrated in the dorsal anterior cingulate cortex. Our findings provide support for a theoretical account in which collective decisions are made through integrating multiple types of inference about oneself, others,...
The Journal of neuroscience : the official journal of the Society for Neuroscience, Jan 18, 2015
Economic choices are largely determined by two principal elements, reward value (utility) and pro... more Economic choices are largely determined by two principal elements, reward value (utility) and probability. Although nonlinear utility functions have been acknowledged for centuries, nonlinear probability weighting (probability distortion) was only recently recognized as a ubiquitous aspect of real-world choice behavior. Even when outcome probabilities are known and acknowledged, human decision makers often overweight low probability outcomes and underweight high probability outcomes. Whereas recent studies measured utility functions and their corresponding neural correlates in monkeys, it is not known whether monkeys distort probability in a manner similar to humans. Therefore, we investigated economic choices in macaque monkeys for evidence of probability distortion. We trained two monkeys to predict reward from probabilistic gambles with constant outcome values (0.5 ml or nothing). The probability of winning was conveyed using explicit visual cues (sector stimuli). Choices between...
Ce document est publié dans lintention de rendre accessibles les résultats préliminaires de la re... more Ce document est publié dans lintention de rendre accessibles les résultats préliminaires de la recherche effectuée au CIRANO, afin de susciter des échanges et des suggestions. Les idées et les opinions émises sont sous lunique responsabilité des auteurs, et ne représentent pas nécessairement les positions du CIRANO ou de ses partenaires. This paper presents preliminary research carried out at CIRANO and aims to encourage discussion and comment. The observations and viewpoints expressed are the sole responsibility of the authors. They do not necessarily represent positions of CIRANO or its partners. CIRANO Le CIRANO est une corporation privée à but non lucratif constituée en vertu de la Loi des compagnies du Québec. Le financement de son infrastructure et de ses activités de recherche provient des cotisations de ses organisations-membres, dune subvention dinfrastructure du ministère de lIndustrie, du Commerce, de la Science et de la Technologie, de même que des subventions et mandats obtenus par ses équipes de recherche. La Série Scientifique est la réalisation dune des missions que sest données le CIRANO, soit de développer lanalyse scientifique des organisations et des comportements stratégiques. CIRANO is a private non-profit organization incorporated under the Québec Companies Act. Its infrastructure and research activities are funded through fees paid by member organizations, an infrastructure grant from the Ministère de lIndustrie, du Commerce, de la Science et de la Technologie, and grants and research mandates obtained by its research teams. The Scientific Series fulfils one of the missions of CIRANO: to develop the scientific analysis of organizations and strategic behaviour.
The capacity for strategic thinking about the payoff-relevant actions of conspecifics is not well... more The capacity for strategic thinking about the payoff-relevant actions of conspecifics is not well understood across species. We use game theory to make predictions about choices and temporal dynamics in three abstract competitive situations with chimpanzee participants. Frequencies of chimpanzee choices are extremely close to equilibrium (accurate-guessing) predictions, and shift as payoffs change, just as equilibrium theory predicts. The chimpanzee choices are also closer to the equilibrium prediction, and more responsive to past history and payoff changes, than two samples of human choices from experiments in which humans were also initially uninformed about opponent payoffs and could not communicate verbally. The results are consistent with a tentative interpretation of game theory as explaining evolved behavior, with the additional hypothesis that chimpanzees may retain or practice a specialized capacity to adjust strategy choice during competition to perform at least as well as...
Uploads
Papers by Peter Bossaerts